What is a Commodity ETF?
Every serious investor should look at the advantages that investing in commodity ETFs can bring to their investment portfolios. Because owning and trading commodities can be very difficult to do on a small scale, funds have come about to allow every-day investors to add exposure to the commodities markets. One of the easiest ways to jump into commodity trading is through exchange-traded funds. Exchange-traded funds, or ETFs, are investment funds that are traded on stock exchanges. ETFs hold assets of different companies, bonds, or commodities, and their share price reflects the net asset value of the fund itself during the course of a trading day.
Commodity ETFs (CETFs or ETCs) focus on commodities such as precious metals, agriculture, and futures. They can be broad or very specific. If you are looking to gain some exposure to agriculture as a whole market segment, there are many agriculture ETF options to choose from, such as the PowerShares DB Agriculture Fund (DBA), which focuses on corn, wheat, soy beans, and sugar. If, on the other hand, you are wanting exposure in a specific commodity, such as gold, there are also many different options for you, such as the streetTRACKS Gold Shares ETF (GLD). Let’s look at the breakdown of commodity ETF options on the market today.
Commodity ETF Breakdown
When you look at the different commodity ETF trading options on the market today, the easiest way to categorize them is to break them down into different sub-groups. These sub-groups will help you see which ETF will fit into your portfolio.
Broad vs Specific ETF
The first sub-group categorization method is to break them down by:
This is discussed as an example in the paragraphs above, and is a great way to customize your portfolio for the right amount of exposure to different commodities.
The second categorization method is to break them down into commodity type. There are many different commodities that can be purchased as an ETF. Below are a few options:
- Soy Beans
- Crude Oil
- Natural Gas
These are just a few of the options available. Notice that with each of these categories and sub-categories, you can get as specific or blended as you want. This is one of the advantages of utilizing ETFs in your investment portfolio. You can add as much exposure to a specific or broad market as you feel comfortable with.
Physically owned commodities vs Futures trading strategy
The third way to categorize your options is to break them into the following:
- Physically owned commodity
- Futures trading strategy
ETFs that physically own the commodity are not as common as ETFs that utilize a futures trading strategy. Most ETFs on the market today utilize a futures trading strategy to roll front-month futures contracts. This makes a difference in the exposure of your money to the commodity, and sometimes doesn’t react in a linear fashion. For example: if you were to purchase a Copper ETF that physically owned the commodity, as the value of the copper goes up, so does the value of your ETF shares in a roughly linear fashion. But owning shares in a Copper ETF that utilizes a futures trading strategy might not behave linearly, depending on other factors. These other factors involve risk in prices along the term structure of the contract, such as a high cost to roll. Make sure you read all the fine print of each exchange-traded fund that you are interested in buying shares in.
Keep these things in mind as you break down the different commodity ETF options that interest you.
Commodity ETF Advantages
Because the every-day investor has limited resources and doesn’t have access to the trading floor, utilizing ETFs for gaining exposure in commodities markets is a great advantage of these types of funds. ETFs can be purchased like common stock, and can be done through a broker, over the phone, or through your online trading platform. They offer many of the same advantages of mutual funds, but with more flexibility, and without many of the built in costs. When it comes to commodity ETF taxation, you will deal with the taxes like you would with any normal common stock. Because of the way ETFs are structured, capital gains or losses are dealt with differently than mutual funds, which often pass along any gain to the shareholder. That gain is then taxable, even if the gain is used to purchase more shares. ETFs are taxed like common shares, with capital gains of the stock price being taxed after you sell or ‘realize’ the gain.
This website is dedicated to providing information to investors about the different commodity ETF options out there. Be sure to read up on each category before jumping into that particular market. Remember that trading commodity ETFs is easy to do, so don’t be intimidated by the big terms. Take the time to learn what this type of fund is all about. There are many advantages to utilizing commodity exchange-traded funds within your portfolio. Good luck and happy reading!